The FCA offers its two cents on Initial Coin Offerings

As mentioned in our client alert last week, regulators across the globe have been speaking out (and in some cases acting out) on initial coin offerings (ICOs). From the U.S. Securities and Exchange Commission (SEC) and the Canadian Securities Administrators (CSA) in the west, to Singapore, Hong Kong, China and Australia in the east, the ICO regulatory atlas is beginning to take shape. The UK’s Financial Conduct Authority (FCA) has now added itself to the map, as it too has released a statement noting that ICOs are “very high-risk, speculative investments”1.

Widely referred to as “token” sales, ICOs involve companies issuing digital coins in exchange for cryptocurrencies such as Bitcoin or Ether. In a similar (but crucially not identical) vein to the way in which a company will publish a prospectus prior to a float, token issuers will produce an online “whitepaper” business plan2 to promote the ICO. The tokens that are issued may represent a share in the firm, or an intangible right to a good or a service.

Until very recently, most token issuers were young companies hoping to fund a future project with the proceeds. However, other forms of ICO do exist. For example, social messaging company Kik (founded in 2009 and valued at more than US$1 billion) has offered investors the chance to purchase “Kin tokens”, which can be used to power future applications on its platform3.

ICOs are becoming increasingly popular, with over US$1.8 billion in cryptocurrency being raised in the first half of 2017, far outstripping the total figure for the entirety of 20164.

What are the FCA’s views?

The FCA has indicated that it will determine whether a specific ICO falls within its boundaries on a case-by-case basis. It also expressly warned that many ICOs fall outside of UK regulatory protections, such as the Financial Ombudsman Service. In addition, it noted that ICO projects can be experimental (as there are no minimum whitepaper standards), and might be based on inadequate documentation. The FCA also suggested these features mean there is potential for fraud.

Whilst not going as far as the People’s Bank of China - which denounced ICOs5 as “essentially a form of unapproved illegal public financing behaviour” - the FCA has certainly warned companies looking to pursue ICOs that they may well be caught by current regulation, and has cautioned would-be token purchasers to conduct robust due diligence. The Dubai Financial Services Authority has followed the FCA’s example, as it too issued a statement noting that these products are high-risk.

What does this mean?

Much like other regulators before them, the FCA has clearly stated that some ICOs, dependent on their characteristics, could fall within their regulatory jurisdiction. This is not surprising as, for regulatory purposes such as licensing, marketing and prospectus requirements, digital tokens need to be analysed on the basis of their characteristics - so not all products or offerings will be treated the same way.

By drawing parallels between ICOs and IPOs, suggesting that ICO promoters, digital currency exchanges and other intermediaries might require authorisation, and noting that digital tokens might constitute transferable securities, the FCA has undoubtedly set the tone for further regulatory scrutiny.